Whose insurance covers oil spills?

Nerd Wallet

Alice Holbrook
When you think of oil spills like Exxon Valdez and Deepwater Horizon – which hit the Gulf of Mexico in 2010 – images of oil-slicked birds are probably some of the first that come to mind.

But wildlife aren’t the only ones hurt by environmental disasters. Deepwater Horizon affected property owners in five states and caused billions of dollars in losses.

Environmental disasters like oil spills are rare, but whom can homeowners turn to when they do happen? Will their insurance policies pay, or is the perpetrator – like BP – responsible? When does the government step in?

What kinds of damage do oil spills cause?
The environmental impacts of disasters like oil spills are some of the most easily recognizable.

“Tarballs continue to wash up on our beaches and coastlines,” said Raleigh Hoke of the Gulf Restoration Network. “New studies are linking BP’s oil to heart defects in some fish. In Louisiana’s Barataria Bay, which was heavily oiled, scientists have found that dolphins are showing signs of severe illness consistent with exposure to oil.”

And when the Gulf suffers, human communities around it also suffer. In some cases, oil damaged homes and other structures belonging to those who live and vacation near the coast. In other cases, the spill affected property values or businesses’ ability to operate – or both at once.

“Generally speaking, most of the people buying around our coastal areas are interested in fishing,” said Kelley Pace, director of the department of finance at Louisiana State University. Although he added that lower property values in the Gulf are complicated – and exacerbated by a series of hurricanes and the recession – “Deepwater Horizon has also been a factor.”

“Until you start having years that are better than average, people may consider the poor fishing when buying or selling properties,” he said.

Not only did the oil spill impact property values, but it disrupted livelihoods, especially those in the fishing industry. “Fishermen and oystermen continue to express concerns about the size of their harvests. According to data from the state of Louisiana, eight of the nine commercial fisheries they track have lower average annual catches than before the BP disaster,” Hoke said.

Who pays when companies screw up?
While homeowners insurance is great for covered damages, oil spills like Deepwater Horizon are not one of them. Homeowners policies typically include exclusions for “pollutants.” This exclusion is vague, but in general, it’s meant to keep insurers from paying for other companies’ mistakes, like a major oil spill.

Government agencies like Federal Emergency Management Agency are also not a good place to turn for help. However, that doesn’t mean the government is uninvolved.

“The government sets the rules for firms to mitigate the damage,” said Pace.

Companies like BP are expected to pay up to $75 million in damages after environmental disasters – which can include claims by homeowners and businesses, as well as clean-up costs – under the Oil Pollution Act of 1990. The legislation was passed in response to the Exxon Valdez oil spill, and in response to Deepwater Horizon, legislators are considering raising the cap.

And if courts find the company that caused the damage “grossly negligent,” polluters can be assessed additional damages under the Clean Water Act.

This happened in BP’s case. “The damages and fines that can be exacted are quite punitive, and that’s being appealed by BP right now,” said David Partlett, a law professor at Emory University.

To meet these obligations, companies may draw on environmental liability policies. These cover clean-up costs and damages, but they do have exclusions. None of the insured’s property or employees are covered, and neither are damages that the insured should have been able to foresee.

The government may cover additional clean-up costs through the Oil Spill Liability Trust Fund, which is financed in part by a per-barrel tax on oil.

How were Deepwater Horizon victims compensated?
Although it wasn’t required, BP set up its own compensation system in response to Deepwater Horizon. “They were trying to avoid a repeat of Valdez, which caused many local businesses to go under because they did not get relatively prompt compensation. They tried to mitigate damage to their image,” said Pace.

People affected by disasters like Deepwater Horizon may sue, but avoiding the court system is often more efficient. “For these big disasters, sometimes it’s better to run these through the compensation system rather than the ordinary legal process,” said Partlett.

According to Stephen Teague, staff attorney at the Mississippi Center for Justice, “This whole recovery process has gone through a few phases.” After BP’s self-administered claims program, the company cooperated with the Gulf Coast Claims facility to continue payouts. And after the liability case settled in 2012, a new compensation program was established through the Federal District Court of New Orleans.

The claims process hasn’t always gone smoothly. “BP believes that the administrator gave payments to large numbers of claimants who had no proper claims,” Partlett said.

This has only led to more litigation, which should be no surprise, Partlett added. “Once you’ve set up a system of this kind, it’s a moral hazard. Everyone will want to come to try and claim. Everyone tries to get to the trough.”

How can environmental disaster compensation work better?
Some will always take advantage of compensation schemes. But those with legitimate claims still need to be paid.

Some think the systems responding to Deepwater Horizon worked as well as possible. “This was probably as smooth as it could be from the standpoint of individuals. BP may wish they had made it a little harder to get money,” Pace said.

Teague thinks that the court-supervised program has solved many problems that plagued the earlier compensation efforts. “People had a lot of complaints that similarly situated people were getting different results,” he said. “I think they were just trying to feel their way through.”

Others question whether corporations can be trusted to compensate fairly. “At the time that the oil was spilling, there was such political pressure on BP. After the turbulence quieted, the same generosity couldn’t play,” Partlett said.

He suggests more government involvement. “A rational system would probably be set up through legislation, a more comprehensive, across-the-board compensation scheme.”

For Gulf residents still awaiting payments, any future reform will come too late.